1. Credit Cards and Consumer Loans
Chapter 7
Credit Cards
and
Consumer Loans

2. Learning Objectives
Compare the common types of consumer credit, including credit cards and installment loans
Describe the types and features of credit card accounts
Manage your credit card accounts to avoid fees and finance charges
Describe the important features of consumer installment loans
Calculate the interest and annual percentage rate on consumer loans

3. 1. Types of Consumer Credit
Closed-End Credit (installment credit)
One-time loans for a specific purpose
Paid back in a specified period of time
Payments of equal amounts (installment debt)
Examples?
Open-End Credit (revolving credit)
Use on an as-needed basis, up to a limit

4. 2. Credit Card Accounts Common Terms: Annual Percentage Rate
Annual Fee
Minimum payment
Principal
Cash Advance
Convenience Checks
Balance Transfer
Credit Limit
Default

5. 2. Types of Credit Cards Bank credit cards Prestige Cards
Lender = the financial institution
VISA / MC etc = the service provider handling the transactions
Prestige Cards
Affinity Cards
Retail (Store) credit cards
Secured credit cards

6. Aspects of Credit Card Accounts
Credit card disclosure information (PG 198)
Teaser Rates
Default rates
Variable interest rate (based on the prime rate)
Preapproved Credit Card Offers
Annual fees
Other Fees (cash advances / balance transfers / paper statements
Liability for lost or stolen cards
Late-payment, bounced check, over-the-limit fees

7. Credit Card Disclosure Info

9. 3. Managing Credit Cards Wisely
Example Statement (pg 203)
Billing date (or cycle closing date)
Due date
Fed law requires bills to be sent at least days before payments are due
Transaction date vs Posting date
Grace period
Time between posting date and due date… full payment must be made within this time to avoid finance charges
There is no grace period if you carry a balance (pg 203)
Returns and credits: be sure to check!
Minimum payment amount

10. The Cost of Making a Minimum Payment
Item
Price
APR
Interest Paid
Price Actually Paid
Years to Pay Off TV
$500
18%
$439
$939 8
Computer
$1000
$1899
$2899 19
Furniture
$2500
$6281
$8781 34

11. The Benefit of Making Larger Payments
Original Balance
APR
Monthly Payments
Years to Pay Off
Total of Payments
$2500
18%
Minimum
Payment 34
$8781
$50 8
$4698
$100 3
$3163

12. Computation of Finance Charges
APR vs. Periodic Rate
How is the average daily balance calculated?
Excluding new purchases
- Pay interest only on previous month’s balance
Including new purchases with grace period
- Pay interest on prior balance
Monthly finance charges =
Average daily balance x periodic rate
Example: Kohls Credit Card with 12% APR
What is the periodic rate? If average daily balance is $1000, what is the finance charge for the month?

13. 4. Installment Loans Secured loans vs unsecured loans
Unsecured loans are granted on the basis of good credit character
Secured loans require collateral or a cosigner
Collateral: Lender places a lien (legal right to seize) on property that is pledged as collateral
Which poses more risk for lender?
Acceleration clause: one missed payment can result in all remaining installments being payable upon demand

14. TOTAL PAYMENTS – PRINCIPLE BORROWED
Calculating an Installment Loan Payment
TIL Act requires lenders to disclose finance charge and APR
Installment loans: usually fixed interest rate and monthly payment remains same
To calculate monthly payments on an installment loan: use chart, pg 209
To calculate finance charges on a loan:
TOTAL PAYMENTS – PRINCIPLE BORROWED

15. Monthly Installment Payment Required to Repay $1000

16. Methods of Calculating Interest
The Declining-Balance Method (PG 210)
(AKA: Simple-interest loans or fully-amortized loans)
Typically used for mortgages
Equal monthly payments: part goes toward interest and part toward principle: much more toward interest in earlier years
Periodic interest rate is applied to the loan balance at the end of each month
Fact: you only pay interest on the balance, which is constantly being reduced
Fact: there are no prepayment penalties )

17. This chart shows an amortized loan
Each monthly payment is a fixed amount
The balance on the loan gradually declines as payments are made
What happens if the borrower decides to pay off the loan early?
Watch out for pre-payment penalties!
Calculations for amortized loans:

18. Example: You borrow $2000 at 9% add-on interest for 2 yrs
The Add-On Method (PG 211)
Used on some installment loans
Interest is calculated up front, added to loan
Add-on rate is used to determine interest (I)
I = PRT
Note: the add-on rate is not equal to the APR
(the APR is approximately double the add-on rate)
Example: You borrow $2000 at 9% add-on interest for 2 yrs
I = PRT I = 2000 x .09 x 2
I = 360
Total Payments = = 2360
Monthly Payment = 2360 / 24 = $98.33

19. An example of Add-on Interest:
Q. What's the difference between a declining-balance car loan and an add-on car loan? If the stated interest was 18% would the total amount of interest be the same over the life of the loan?
Most car loans are declining-balance interest loans. You make the same payment each month, with part of the money paying the interest and part paying back the principal you borrowed. During the first 14 months of a 60-month loan, you will pay more interest than principal each month, but then it will shift and more of your payment will go toward principal. But the key thing about DB loans is that you only pay interest on the balance, which is constantly being reduced. And there's usually no penalty for paying the loan off early. Add-on loans are more costly than simple interest loans. They require you to pay interest on the full amount of the loan for the entire loan period. That interest is "added on" to the principal and the sum is divided into an equal number of monthly payments. Some of that interest is refunded if you pay the loan off early. But lenders often keep 20% of that refund as a prepayment penalty. THE RULE OF 78s
DB Loan: if you borrowed $20,000 for 60 months at 18% APR, your monthly payment would be $508 and your total interest over the life of the loan would be $10,472.
Add-on Loan: If you borrowed $20,000 for 60 months at 18% add-on interest, your monthly payment would be $633 and you'd pay a total of $18,000 in interest.
                                                                                                    
Experts suggest that you always go with a DB loan, not an add-on loan.

20. The Discount Method (PG 212) Used on some installment loans
Interest is calculated up front, paid up front
Discount rate is used to determine interest (I)
I = PRT
The interest is subtracted from the amount of the loan and borrower receives remainder.
Example: You borrow $2000 at 9% discount rate for 2 yrs
I = PRT I = 2000 x .09 x 2
I = 360
= 1640
Borrower pays $360 up front; receives $1640